The first commercially successful U.S. exchange-trade fund (ETF) turns 20-years old this month. SPDR S&P 500 (Ticker: SPY) was launched on January 22, 1993 after spending several years in SEC registration. It was an evolution in the mutual fund industry. Today, SPY is the largest ETF by asset in the exchange-traded product (ETP) industry that has total assets of over $1.4 trillion.
SPY was marginally successful in the first year, although not a blockbuster. It ended 1993 with a respectable $464 million in assets. It took another 2 ½ years before SPDR launched a second ETF. By the end of 1997, there were still only two ETFs trading on U.S. exchanges with assets totaling $6.2 billion. It was hardly a speck within the multi-trillion dollar mutual fund industry.
The global stock market crash of 1987 sparked the idea for ‘stock baskets’ which allowed the trading of multiple securities in one trade. This would allow investors to own a portfolio of securities without having to buy individual shares in each constitute.
The Toronto Exchange in Canada was the first to issue an ETF-type product known as Toronto Index Participation Units (TIP 35) in March 1990. TIP allowed investors to participate in the performance of the TSE 35 Composite Index in just one trade. The product was followed by HIPs, which tracked the Toronto 100 Index.
The U.S. Securities and Exchange Commission was a little slower in its review and rewriting of securities regulations to make way for exchange-traded products. In 1990, the SEC issued the Investment Company Act Release No. 17809 and ultimately paved the way for the formation of mutual funds that allowed for share creation and redemption during the day.
Specifically, the Release No. 17809 granted investment firm Leland, O’Brien and Rubinstein (LOR) the right to register a new security called an Index Trust SuperUnit issued by an entity called a SuperTrust. The product was an index fund of sorts, designed to give institutional investors the ability to buy or sell an entire basket of S&P 500 stocks in one exchange-traded product. The SuperTrust structure had share creation and redemption characteristics of an open-end fund and the trading flexibility of a stock.
SuperUnits traded on an exchange similar to the way closed-end funds would trade. But unlike closed-end funds, if SuperUnits developed a discount to its underlying securities value, then institutional investors could arbitrage the units and profit risk-free. This risk-free arbitrage trade locked in a small profit for the institutional investor and kept the SuperUnit market price in line with its underlying value. Although arbitrage sounds complicated, it is actually quick, easy, and practically fully automated. The entire transaction can be accomplished in a few moments.
LOR filed for their SuperTrust in 1990, and on November 5, 1992, the SEC completed their regulatory review. Long delays are common at the SEC when filing for any new security product. Their first SuperUnit was launched in December 1992 to track the S&P 500 index. It had a maturity of three years, at which time a second SuperUnit was supposed to replace maturing units.
Unfortunately for LOR, there was no second issue. Though the concept was a unique solution for institutional investors, one detriment to success was that SuperUnits had only institutional appeal. A large minimum investment size, the complexity of the product, and adverse tax rulings turned individual investors cold to the idea.
Where there is opportunity, there is innovation, and by the time SuperUnits hit the street, something better was already brewing. The American Stock Exchange took advantage of the Investment Company Act Release No. 17809 and petitioned the SEC to allow the creation of the first Standard & Poor’s Depositary Receipts (SPDRs). The official name is SPDR Trust, Series 1, but they are better known as SPDR S&P 500. State Street Global Advisors (SSGA) manages the fund, which began trading on the American Stock Exchange in January 1993.
Like SuperUnits, the market value of SPDRs S&P 500 is kept very close to the underlying index through an arbitrage mechanism described earlier. Institutional investors have the opportunity to profit from a small mismatch in price between the market value of SPDR S&P 500 and the stocks in the S&P 500 index. If one value is greater than the other, the expensive one is sold and the cheap one is bought. The arbitrage trade would be repeated over and over until the discrepancy between the ETF and its underlying value was so small that there is no profit left from arbitrage.
SPDR S&P 500 was successful, while SuperUnits were not. One reason SPDRs succeeded was because individual investors could afford to buy them. Each unit trades at approximately one-tenth the index value of the S&P 500 index. If the S&P 500 was quoted at 1500, the price of one SPDR unit is $150. That is a simple and elegant pricing structure that everyone understands, at a price-per-unit that investors can afford.
SPDRs also filled a big void in the brokerage industry. Stockbrokers needed a way to invest their clients’ money in index funds during the mid- to late 1990s. At the time, investors at large wire houses were transferring billions of dollars out of those firms and into the low-cost Vanguard 500 Fund. SPDRs S&P 500 allowed brokers to offer clients an alternative to Vanguard, which helped slow the outflow of assets from the wire houses.
SPDR S&P 500 is 20-years old and going strong. It has nearly $90 billion in assets and it remains the largest ETF on the market. It set the pace for the large and growing ETP market and has provided investors with more alternatives.
Today, about $1.4 trillion is spread across more than 1,450 ETPs offered by dozens of companies. Most of the investments in ETPs are concentrated among the top four providers: BlackRock iShares, Vanguard, State Street Global Advisors (SPDR) and Investco PowerShares. These four firms manage close to 90 percent of the assets in the ETP marketplace.
See The ETF Book for more information about the history of exchange-traded products.